Solutions To Inflation In Oil Prices

Solutions: (Use both monetary policy and fiscal policy)

The most effective way of countering the detrimental effects of the rapid increase in oil price are through macroeconomic policies. However the use of monetary policy in this scenario may have varying effects. If the government attempts to reduce the inflation, unemployment, the expansionary monetary policy will be an appropriate choice. For instance, the government will cut the interest rates, households and firms will borrow as much as money as they can. Hence, consumption and investment will increase; this will boost Australian economy, the economy will shift back to potential output and unemployment will be reduced. Accordingly, if the government wishes to contain inflation, it might I adopt the contractionary monetary policy. This will impose an adverse effect to the Australian economy, which will restrain the aggregate demand; however this might cause an even large contractionary gap with unemployment. Therefore, a more suitable approach will be adopting fiscal policy.

The appropriate choice fiscal policy will be the expansionary fiscal policy. In terms of adopting this policy, the government will attempt to increase the government spending and increasing net taxes. This transmission will increase boost aggregate demand, the economy will go back to potential output but at a much higher level of prices. Consequently, the unemployment will be reduced. Nevertheless, the more comprehensive policy adoption will be the mixture of monetary and fiscal policy, for instance, increasing interest rates and government spending at the same time.